On October 27, 2009, influential Democratic US Congressmen Charles B. Rangel and Richard E. Neal introduced a bill before Congress with the goal of a stricter implementation of US tax laws applying to assets outside the US and designed to minimize US tax evasion. The legislation, entitled the Foreign Account Tax Compliance Act (FATCA), contains a very simple requirement: Foreign financial institutions wanting to do business in US investments should be subject to similar reporting requirements as US financial services providers. This is, in effect, legislation by capital markets. The law will present enormous challenges for approximately 200,000 financial services providers and many other industries around the world. The bill was passed by the US Congress on March 17 as a part of the "Hiring Incentives to Restore Employment Act" ("HIRE Act", also called the "Jobs Bill") and was signed by President Barack Obama on March 18. The first implementation guidance was published at the end of August and enters into effect in various stages up until January 2013.

FATCA imposes a withholding tax of 30% on all payments flowing out of the USA ("withholdable payments") to a foreign financial intermediary ("FFI") in cases where the intermediary has not concluded an agreement with the US tax authorities. With such an agreement, the affected FFI obligates itself to automatically report accounts which it manages for US persons and "US-controlled" foreign legal entities. The payments, collected at source, include not only the usual interest, dividends and similar types of investment income, but also include the gross proceeds from assets from which interest, dividends, and similar income could be gained, primarily payments from the sale of stocks and bonds. In view of the draconian tax consequences, an automated information exchange can be spoken of in conjunction with FATCA.

The definition of an FFI and its reporting requirements are addressed in more detail in the corresponding regulations. There are three categories of FFI]s, starting with foreign banks and financial institutions. The broadly-drawn definition of "financial institution" includes life insurers offering more than purely death-risk insurance. Securities traders are included in the third category, including collective investment vehicles such as investment funds, hedge funds, and private equity investments.

The FFI has to divide its obligations into four responsibilities. It requires the identification and reporting of existing and new client relations involving US individuals or U.S- controlled foreign companies. The level of detail with which the FFI is charged in order to ensure that truly all US taxpayers concerned will be included without exception well exceeds the normal anti-money laundering "Know-Your-Customer" standard and gives the impression that the IRS intends to treat foreign financial intermediaries as it does banking institutions located in the US. It is noteworthy that a one-time analysis of existing client data does not sufficient, rather periodic re-examinations must be conducted. Banks which constitute contractually-bound FFI's will also have, in addition to FINMA, the regulatory reporting requirements of the US tax authorities, or "agreed-upon procedures", to comply with, which in view of the national regulating authorities can hardly be expected to go without objection. Conflicts between divergent legal systems are pre-programmed.

What is striking is the intentional incongruity existing between the payments collected on the one hand and the FFI's registration obligations on the other. In addition to the name of the account holder and the US Social Security Number (the "Employment Identification Number"), the registration requirements include an account summary and gross realized revenues, withdrawals made by the account holder, as well as the highest month-end balance of the previous 12 months.

The new rules represent an unprecedented challenge for the banking industry. The additional efforts in compliance and in daily operations will be considerable. According to FATCA guidance, existing client relationships must all be identified, documented and classified. It is to be feared that to this end it will be necessary to conduct comprehensive client surveys. The fact that certain transition periods exist for existing client relationships, depending upon the amount held in the accounts, does not really help. Banks will have to consider whether it is not more efficient to examine all existing relationships at once and, where necessary, to supplement the documentation.

In the classification of clients in the banking system, dealings with natural persons will be identified with relatively little effort. For other relationships, the codes available for automated classification in the IT system are insufficient. It is not merely a matter of basic classification of businesses as FFI's and NFFE ("non-financial foreign entities"). The most recently published implementation regulations for FATCA provide for classification of the accounts of legal entities in eight different types. This means the necessary adaptation of the IT system with regards to client master data will be very costly. The IT must additionally be ready at any time to recognize whether it is dealing with a US account with reporting, an account with additional withholding tax, or a fully-documented foreign account.

Following the initial classification it must be ensured that each time in the future where address and other data changes occur, re-verification takes place and, where necessary, new required documentation is included, as well as when a reclassification occurs.

Before an FFI decides whether to sign a FATCA Agreement or to forgo withholding US securities for itself and its clients in the future, it must conduct a cost-benefit analysis. In addition to the one-time implementation costs for IT adaptation and the examination, classification and additional documentation of existing client relationships, the implementation of FATCA will also dramatically change and increase the costs of ongoing operations. Data for the new reporting of US accounts must be collected, the report must be done electronically in a data format defined by the IRS, and the withholding tax levied must be declared correctly and sent out within a certain timeframe. For example, in the future all payments from mutual funds and structured products by "Passthru-Payments" (payments that do not directly originate from a US source but are indirectly related to one) must be examined.

How then should the Swiss FFI decide? To sign no agreement with the IRS and to completely avoid US investments (including indirect investments such as mutual funds, structured products, swaps etc.) is not a realistic alternative for an internationally active bank. There would also be the risk that certain clients with a greater interest in US investments would consider changing to a bank which has not signed an agreement. Banks whose clients hold only limited US investments and who could forgo doing business with USnexus, must seriously ask themselves whether the costs and risks bear a proportionate relationship to any benefits. In this case, they risk that some clients will change to banks that have entered into an agreement.

A company located in Switzerland that does meet the definition of an FFI can nevertheless be affected by the FATCA requirements, namely where it receives income from American sources or profits from the sale of American securities through an American paying agent or an FFI. In this case such a business must confirm that it is not held by US investors who hold a share of at least 10% each. Otherwise the company must provide the American paying agent or FFI with the name, address, as well as the taxpayer identification number of each qualifying US investor. This information will be passed on to the IRS. Should the information not be openly provided to the American paying agent or FFI, or should the information be known or suspected to be incorrect, the American paying agent or FFI is obliged to withhold taxes at 30% on all US payments and revenues. There are some exceptions to this rule, which apply to publicly-traded enterprises and related group associations. In addition, the IRS has recently made reference to further exceptions, for example, foreign holding companies holding active investments outside of the finance sector, newly-founded companies as well as intra-company financial companies outside of the finance sector.

One could conceivably argue that these measures will combat tax evasion abroad by US persons. However, the FATCA rules are too broadly drawn and shoot well past the mark. One could also take the view that it cannot be assured that the regulations will actually fulfill their purpose, but in fact, that they will possibly serve as a hindrance. Beyond that, the whole FATCA regime will have a negative impact on employment in the US. The following is a description of the consequences to various sectors.

Banks

The adjustment to a US-compatible, global withholding tax system for numerous financial institutions world-wide has no relation to either the size of the problem itself or to the size of the US market in comparison the the global economy. FATCA is so far-reaching that banks – in cases where they cannot adequately meet the legal requirements – will have no choice but to refuse their services to all US clients or to rid themselves of all US investments held in their clients'names. In the future, American clients wanting to hide something from the IRS will avoid American stocks and seek out banks without FATCA obligations. Thus, the FATCA rules could achieve just the opposite of the desired transparency in tax issues.

Trustees

The manner in which the US wishes to implement FATCA automatically makes most trusts FFI's. The duty of a trust is to hold assets for the beneficiaries. This is, in essence, the definition of a trust relationship. FATCA will effectively force the trustee to decide whether to adopt the FATCA rules or rid itself of all US investments and all trust mandates with possible ties to the US.

Investment Funds

FATCA would have the effect that numerous funds, which due to US SEC rules are already unavailable to US investors, nevertheless fall under the regulations. Compliance will be made difficult by the fact that through the investment of a sole US person, the fund will become a US person itself. How can this be structurally assured over time in terms of funds and even more complex "funds of funds"? Funds must seriously consider the introduction of FATCA. Without FATCA these funds would be excluded from investments in the US.

Insurance providers

FATCA clearly affects insurance providers as well. The implementing regulations provide for two different systems for such businesses. The first applies to property and accident insurers, the second to life insurers. Relevant to the latter is that policies with payments resulting from pension or annuity payments fall under the FATCA regulations. Swiss insurance providers will be sorely affected by this.

Retirement funds

According to the regulations, employer-financed pension funds do not fall under the FATCA provisions, as the risk of tax evasion is very small. At the same time the regulations provide that all pension investment entities not financed by the employer – for example third pillar – fall under the FATCA provisions.

As initially designed, a domestic focused law intended to improve tax transparency, FATCA has become a monster causing havoc of the world economy, through which all participants will lose, including Americans. Many describe FATCA as the "neutron bomb of the global economic system". The predicted tax revenues of approximately USD 850 million annually are countered by enormous implementation costs, not to mention the resulting operating costs. A provisional and very rough estimate shows average introduction costs of approximately $ 5-10 million per FFI, which if introduced by all FFI's results in global costs of $ 1000-2000 billion. This represents approximately the yearly gross domestic product of Brazil or India. The financial institutions would pass along these enormous costs to the clients by way of higher fees, and due to reduced profits of financial businesses, countries will have to take considerable tax revenue losses into account. Additionally, financial and direct investments in the US will decrease, possibly in considerable amounts, to the detriment of employment and tax revenue in the USA. US persons abroad will certainly be met with less enthusiasm as clients.

As a result of the issues regarding banking secrecy, information exchange and the resolution of the issues from the past, Switzerland has at this point in time no possibility to take the world-wide lead in matters regarding FATCA and to attempt to bring the US government to a more reasonable solution. This article should serve as an appeal to the EU commission, the large financial institutions of the world and not least to the US government and US Congress, to review FATCA, to pursue the stated, very valid, goal of improved compliance with the US tax laws with more proportionate measures, and thereby avoid a descent into an economic and administrative nightmare.